Even though September is considered the biggest redemption month for Global EM sovereigns, the favorable market conditions should attract a flurry of issuers to the market over the next few weeks, believe analysts at Barclays. Andreas Kolbe and team said in their August 25 research piece titled “A Crowded Approach” that they expect the Ukrainian government to complete its IMF review within the next month despite obstacles to reform that jeopardize the country’s medium-term outlook.

Increasing importance of passive funds in EM credit

On the back of the global macro environment supporting high-yielding assets, EM assets have continued to benefit. Kolbe and colleagues point out that though inflows into EM bond funds have not touched the July record levels, they remain very solid.

The recent HSBC Hedge Weekly highlighted several low volatility strategies in the credit space outpacing bond benchmarks and clocking some of their best historical performances.

The Barclays’ analysts believe the favorable market conditions will attract several issuers such as GCC sovereigns and select issuers from regions that have so far fallen behind expectations. The analysts argue that unless flows into EM credit turn sharply, supply should generally be met with healthy demand. Though the analysts are not concerned about a likely pick-up in EM credit supply in September, they believe core rates are a key risk to the EM rally. They believe any change in the narrative of central banks’ accommodative stance and any meaningful correction in core rates will likely pose adverse consequences for EM risk premia.

EM sovereign credit redemptions EM Credit, EM Rally, Emerging Markets

Kolbe and team caution that in the event of flows into EM reversing, the increase in the share of passively managed funds could exacerbate volatility. They believe indiscriminate buying in the flow-driven rally will turn into similar selling and “gappy” price action.

Importance of passive funds

“No change expected from Brazil, Columbia, Israel central bankers”: Barclays

Citing Bank for International Settlements data, Bank of America highlighted in its recent “Flow Show” report that the global emerging market credit market constitutes a relatively small chunk of the global debt market. The BIS data indicates that global emerging market external debts stands at 14% of world external debt.

Kolbe and colleagues point out that last week brought nervousness ahead of Fed Chair Janet Yellen’s speech, and the firmer USD has weighed on EM FX/local markets. They believe that besides Yellen’s speech, there will be attention on some EM monetary policy announcements, including in Israel, Brazil and Columbia. The Barclays analysts don’t anticipate any change from any of these three central banks. They expect China PMI data to confirm the likely moderation in growth in the months ahead.